Acompany’s warehouse of inventory
gives banks many clues about the
operation’s efficiency, cash flow and overall financial health. If inventory controls
are not in place, accessing credit lines and
funds to obtain additional inventory may not
be possible in today’s banking environment.
“There is a significant cost to handling
inventory, warehousing it and not moving it
quickly enough,” says Louise Kirk, CPA, a
director in the assurance services department at SS&G Financial Services, Inc. “With
banks tightening up, there are less funds
available. Companies need to control inventory levels and stock the right inventory.”
Smart Business spoke with Kirk about
ways to develop effective inventory management controls.
What signs indicate that a company’s inventory is excessive and could harm financial
performance?
Companies can compare certain key performance indicators to similar businesses in
their industry, looking at measurements such
as inventory turns, return on investment and
gross profit margin. Excessive inventory may
come to light when the company begins feeling financial ‘pains’ associated with too much
of the wrong items or not turning inventory
quickly enough. Cash flow might be tight,
accounts payable may be excessive or aging
beyond what is desirable. When assessing
inventory flow and warehouse stock, the
executive team should ask: How much inventory do we really need based on lead time to
meet customer needs? Depending on the
nature of the business, a company may be
assembling products start to finish, producing a particular component or acting as a distributor. Regardless, when products are not
moving efficiently, companies will struggle
with cash flow, therefore limiting their ability
to grow and prosper.
How does a company get back on track?
Careful planning, discipline and training are
necessary so everyone involved, from purchasing to production and distribution,
understands what steps are necessary to be
competitive in today’s economy. One consideration is implementing a lean manufacturing approach, which will focus on improving the
flow of the production process and elimination of waste. This process will establish
effective controls and procedures that will
require the buy-in of all departments and individuals and improve the company’s bottom
line. The purchasing department should
establish a replenishment schedule for each
inventory item, which will provide efficiencies in the flow of inventory and reduce overall costs. Establish measurable goals and
objectives, such as inventory turns and
return on investment, for purchasing and
sales personnel. Motivate these individuals to
reach their goals by tying performance to
compensation. Implementing these types of
systems is a top-down process, which
requires management’s commitment to putting a process in place and training every
employee to follow the system. It is important to make everyone accountable.
What can a company do to ensure the
processes are being followed?
Establish an inventory locator system along
with a cycle inventory system that will
improve efficiencies and identify discrepancies on a regular basis. Document all procedures and routinely test that they are being
followed. Be sure effective security systems,
both within and outside the facility, are in
place to protect the company against theft. It
is useful to identify and implement an inventory management software system that will
enable management to capture crucial information and evaluate key performance indicators to assist in projecting customer needs.
Providing tools, processes and procedures
will assist in identifying and carrying items
that will reap higher profit margins and
improve cash flow.
What can a company do in the meantime
with slow-moving or obsolete inventory?
Implement a system to identify and eliminate slow-moving or obsolete inventory that
is consuming valuable warehouse space
along with capital. There is value in slow-moving and obsolete inventory items, but if
these items pile up and sit over a period of
time, they become worthless. Inventory that
isn’t turning or is no longer relevant to a company’s process can sometimes be returned to
vendors. Offer special reduced pricing to
help turn the inventory quickly. Give sales-people incentives to concentrate their efforts
on moving that inventory. Determine if there
is a market via the Internet or scrap. Or,
donate the items to charity and realize tax
advantages (though first discuss this with
your tax adviser).
Why will banks scrutinize a company’s inventory management before granting loans?
Banks want proof that the money they lend
a company for inventory investments will
provide a good return. If inventory is sitting,
it is not paying off debt. A bank will review
inventory turns and ask questions about
excessive inventory, slow-moving items,
aged accounts payables and how all this
affects cash flow. (If the company were moving and selling inventory, it would have cash
to buy more rather than approach the bank.)
A company will impress a bank if it has a
well-planned inventory system in place.
LOUISE KIRK, CPA, is a director in the assurance services department at SS&G Financial Services, Inc. (www.SSandG.com). Reach her
at (800) 869-1835 or [email protected].
